To achieve its objective of price stability, the European Central Bank (ECB) uses a series of monetary policy instruments. The main instrument is the set of key interest rates, which it steers through open market operations, standing facilities and minimum reserve requirements. However, since the financial crisis, the ECB introduced new tools, complementing these instruments, to respond flexibly to the new challenges that have arose with the aim of keeping inflation at 2% over the medium-term (see the section on the ECB’s monetary policy strategy). These new tools include negative interest rate policies (NIRP), targeted longer-term refinancing operations and a broad asset purchase programme. Added to this is forward guidance, through which the ECB announces its intentions with regard to the path of key interest rates and the horizon of its asset purchase programme.
Subsequently, following a sharp increase in inflation in the euro area in 2021, the Eurosystem embarked on the process of normalising its monetary policy and conducted a review of its operational framework in order to ensure that it remained appropriate in this new context.
What has been decided in the review of the operational framework?
In December 2022 the Governing Council announced that it would conduct a review of the operational framework for the conduct of monetary policy in the euro area to ensure that it remained appropriate during the process of balance sheet normalisation.
The decisions taken, announced on 13 March 2024, set out the key principles and parameters for implementing monetary policy and providing central bank liquidity against the background of a gradual reduction in excess liquidity in the banking system, which will, however, remain considerable in the coming years.
In particular, the Governing Council decided:
- The monetary policy stance will continue to be guided by the adjustment of the deposit facility rate.
- Liquidity will be provided through a broad mix of instruments. The main refinancing operations (MROs) will play a pivotal role in meeting banks' liquidity needs and will continue to be conducted through fixed rate tender procedures with full allotment. The spread between the main refinancing rate and the deposit facility rate will be reduced to 15 basis points as from 18 September 2024.
- The three-month longer-term refinancing operations (LTROs) will continue to be conducted as fixed rate tender procedures with full allotment.
- At a later stage, structural longer-term refinancing operations and a structural portfolio of securities will be introduced, once the Eurosystem's balance sheet starts to grow again in a sustainable manner, taking into account legacy bond holdings. These operations will make a substantial contribution to covering the structural liquidity needs of the banking sector arising from autonomous factors and minimum reserve requirements. The structural refinancing operations and the structural portfolio of securities will be calibrated according in accordance to the principles of the operational framework and to avoid interference with the monetary policy stance.
- The interest rate on the marginal lending facility will also be adjusted so that the spread between the marginal lending rate and the MRO interest rate remains unchanged at 25 basis points. These changes will take effect as from the sixth maintenance period of 2024, starting on 18 September 2024.
- The reserve ratio for determining banks’ minimum reserve requirements remains unchanged at 1%. The remuneration of minimum reserves remains unchanged at 0%.
- A comprehensive collateral framework for refinancing operations will be maintained.
- A review of the key parameters of the framework is foreseen in 2026 on the basis of the experience gained in the intervening period, or earlier if necessary.
A review of the key parameters of the framework is foreseen in 2026 on the basis of the experience gained in the intervening period, or earlier if necessary.
What are the principles for implementing monetary policy following the review of the operational framework?
On 13 March 2024 the Governing Council agreed on a set of principles that will guide monetary policy implementation in the future:
- Effectiveness: the main objective of the operational framework is to ensure the effective implementation of the monetary policy stance in line with the provisions of the EU Treaty. This is best achieved by steering short-term money market interest rates towards levels that are closely in line with monetary policy decisions. Some volatility in money market interest rates can be tolerated as long as it does not blur the signal about the desired monetary policy stance.
- Robustness: the operational framework should be robust across different monetary policy settings and liquidity and financial environments, as well as consistent with the use of the monetary policy instruments envisaged in the ECB's monetary policy strategy. The Eurosystem intends to provide central bank reserves using a wide variety of financial instruments to offer an effective, flexible and stable source of liquidity to the banking system, which will also support financial stability.
- Flexibility: the euro area banking sector is large and diverse in terms of the size, business models and geographical location of banks. An elastic supply of central bank reserves based on banks' needs is therefore the most appropriate way to effectively channel liquidity across the entire banking system throughout the euro area and to contribute to flexibly absorbing liquidity shocks.
- Efficiency: an efficient operational framework provides the desired monetary policy stance without interfering with it, respecting the principle of proportionality and taking into account net side effects, such as risks to financial stability. The framework should also preserve financial soundness. A financially sound balance sheet supports central bank independence and allows the smooth conduct of monetary policy.
- Open market economy: the design of the operational framework should be consistent with the smooth and orderly functioning of markets, including money markets, which are most closely related to the implementation of monetary policy. This is conducive to an efficient allocation of resources, an effective price discovery mechanism and the smooth transmission of monetary policy.
- Secondary objective: to the extent that the different configurations of the operational framework are equally conducive to ensure the effective implementation of the monetary policy stance, the operational framework should facilitate the ECB’s pursuit of its secondary objective of supporting the general economic policies in the European Union, in particular the transition to a green economy, without prejudice to its primary objective of price stability. Accordingly, the design of the operational framework will seek to incorporate climate change considerations into structural monetary policy operations.